Outside of the world of stocks, bonds, exchanged-traded funds and similar investments, a universe of alternative investments awaits today’s sophisticated investors.
One of the most promising investment types, and one that has outperformed many other types of investments in recent decades, is known as private equity. Private equity is a broad term that encompasses a spectrum of private capital markets, along with numerous private equity firms that specialize in various investment strategies.
These firms typically raise funds from high-net-worth investors and invest the capital in private companies that promise high returns. The investors are paid following a liquidation event such as an initial public offering or an acquisition.
The partners at private equity firms manage the funds to yield the most favorable returns for their clients, usually with an investment period lasting between four and seven years. [i] Many private equity firms seek clients who are willing to invest up to $25 million, but some have minimums as low as $50,000 to $100,000.
The following is a selection of the more common private equity strategies available to investors:
Private Equity Real Estate – These funds permit wealthy individuals and institutions to invest in debt and equity holdings consisting of property assets. With this type of investment, general partners invest in real estate properties in different locations. By joining a fund, outside investors become limited partners and their money is pooled with other investors. The fund managers use these funds to create a portfolio of properties designed to increase profitability and reduce risk.
Fund of Funds – This type of fund consists of the shares of numerous private partnerships that are invested in private equities. The fund of funds offers a way for firms to maximize efficiencies and lower the required minimum investment. This often equates to a large degree of diversification because a fund of funds may invest in hundreds of companies. As a result of its size, the fund of funds often provides less risk than what an investor would encounter with an individual private equity investment. The downside is that additional fees are paid to the fund of funds’ manager. The minimum investment can be as low as $100,000 to $250,000—although it may not make sense for investors to exercise this strategy unless they have a net worth greater than $1.5 million.[ii]
Private Equity ETF – Another option is the private equity exchange-traded fund (or “ETF”). In this model, investors can buy shares of an exchange-traded fund tracking a publicly traded company’s index that invests in private equities. Unlike the fund of funds that requires a minimum investment of at least $100,000, a private equity ETF doesn’t contain this requirement because investors purchase individual shares via a stock exchange. However, like the fund of funds, investors may have to pay additional management expenses. Additionally, your brokerage may charge a fee each time you buy or sell shares.
Special-Purpose Acquisition Companies – A final alternative involves investing in publicly traded shell companies that specialize in making private equity investments in undervalued businesses. However, Special-Purpose Acquisition Companies (or “SPACs”) may involve heightened risk, and could be under pressure to comply with investment deadlines.